Student loan forgiveness sounds nice in theory.
But just like everything else that sounds too good to be true, there’s a catch.
The quick and dirty on student loan forgiveness
Unless you’re a public servant or a teacher, you might be eligible for the following three types of loan forgiveness programs:
Income Contingent Repayment (ICR): Your payments are based on your income, family size, loan balance, and interest rate
Income Based Repayment (IBR): Your payments are based strictly on your income and family size. The balance of the loan and interest rate are not used in calculating the monthly payment, and you pay a flat 15 percent of discretionary income toward student loan debt repayment
Pay As You Earn (PAYE): Your payments are 10 percent of discretionary income. Qualifying for PAYE is more difficult than for the other options, however this plan usually offers the lowest monthly payments
These programs offer loan terms of 20 to 25 years. At the end of this period, your remaining loan balance would be forgiven.
But here's where things get a little tricky.
Repeat after me: 'I'm not getting free money'
I'll say it again. Your forgiven loan balance isn't free money.
According to the Internal Revenue Service, the balances from any forgiven loans are considered income. And that means Uncle Sam will require you to pay taxes on that income.
Plus, if you took any deferrals or hardship forbearances during your repayment term, any interest fees will have been added back to your overall debt.
Consider this example: After making payments for 25 years, you’re left with $40,000 in student loan debt.
While your loan balance may be “forgiven,” you’ll receive a hefty income tax bill based on that $40,000. Depending on your tax bracket, that bill could be approximately a third of that amount—and don’t forget state income taxes.
You have to qualify... and requalify... and requalify...
Until your student loan amount is forgiven, you must satisfy a list of requirements each calendar year. For instance, you may need to meet certain income caps, keep steady employment, and make on-time loan payments.
Translation? Your monthly payments will increase or decrease according to your new status.
Moreover, you’re committing to the fact that you won’t earn above a certain salary and won’t be fired from your job. You also can’t miss or fall behind on payments.
Basically, you’re capping your income-earning potential, and predicting the future.
So, what’s the alternative? Many private lenders and new student loan platforms offer the chance to refinance your debt. This is worth considering if you don’t meet eligibility requirements, but still want to consolidate or re-negotiate your loans for a lower rate, payment, or term.
In the end, student loan forgiveness can mean big taxes and tight rules to follow. So make sure you’re educated on the risks and available options.
To learn more about the Public Service Loan Forgiveness Program, click here.
To learn more about the Teacher Loan Forgiveness Program, click here.
If you are interested in learning more about what loan repayment plans are available, click here.